China’s Economic Slowdown: How Bad Is It?

Tuesday was another nervy day on Wall Street: the Dow closed down almost four hundred and seventy points, or about three per cent. The immediate issue, once again, was China, which by some measures is now the world’s second-largest economy. In Beijing, the government released a set of figures indicating that output from the country’s enormous manufacturing sector is declining. Another new statistic showed that the Chinese services sector, which has been growing pretty strongly, is now exhibiting some weakness, too.

At least two interpretations of the data are possible. The optimistic reading is that several one-off factors, including the temporary shuttering of factories in northern China to relieve pollution in Beijing, depressed the manufacturing figures, which should rebound in the months ahead and reassure the markets. Recently, the government has taken a number of policy measures to bolster demand, such as accelerating infrastructure projects, lowering interest rates, and devaluing the Chinese currency. Over the weekend, Li Keqiang, the Chinese Premier, said that these measures were already having an effect, and he assured the citizenry that the government, in order to meet its objective of seven per cent annual G.D.P. growth, would do more if necessary.

A pessimistic reading is that the negative forces impacting the Chinese economy, which include the bursting of a stock-market bubble, a huge debt burden, and slowing growth in some of the country’s trading partners, are threatening to overwhelm Beijing’s efforts to stabilize things. The official manufacturing index, which is similar to the U.S. purchasing-managers’ index, has zigzagged quite a bit during the past few years, but in August it fell to the lowest level seen since 2012. And the bad news was confirmed by a private-sector survey, from Caixin/Markit, that also showed manufacturing output declining.

So, which version is right? That’s not easy to answer. As I indicated in a post a couple of weeks ago, the fact that China’s debt (most of it private) has grown extremely rapidly in recent years—according to some estimates, total debt now comes to about a hundred and eighty per cent of G.D.P.—suggests the country may be facing a classic bust. At the same time, however, China has some advantages that other developing countries, like Mexico and Argentina, didn’t have when they ran into trouble, including a relatively low level of public-sector debt and very large foreign-currency reserves.

There are a number of other factors that make it difficult to get a handle on what’s really happening. First, many analysts don’t trust the official figures, particularly for G.D.P. growth, which showed the economy still growing at an annual rate of seven per cent in the first and second quarters of the year—i.e., exactly on target. On Monday, South Korea, which sells everything to China, from cell phones to computer motherboards and car parts, announced that its exports to its biggest trading partner fell by almost nine per cent in August. While some of this fall was probably a reflection of the explosion in the port city of Tianjin, it was also an independent indicator that China’s voracious demand for imports, many of which it uses to build goods for export, is waning rapidly.

Secondly, the policy process in China remains opaque, and that’s putting it mildly. Over the weekend, for instance, the government indicated that it would no longer seek to prop up the Shanghai stock market, which is down about forty per cent from its June peak, by ordering banks and other state-run entities to buy equities. On Tuesday, however, a number of Chinese brokerages, which are subject to government influence, announced in regulatory filings that they had upped their exposure to stocks. In addition, CNBC reported that Chinese financial regulators issued a statement encouraging firms to buy back shares and support the market. Which is it—hands on or hands off?

Finally, it’s hard to know what impact the bursting of the stock-market bubble will have. On the one hand, the Chinese market is relatively small by Western standards, and the number of investors is still small relative to the huge population. It’s also true, however, that some of China’s wealthiest people, and its largest companies, were playing the market with borrowed money, and there will be casualties. What is unknown, at this stage, is how serious the damage will be, and what impact the fall in prices will have on over-all business and consumer confidence. But in any serious market decline, there is a danger of self-fulfilling cycles developing, which can have a big impact on the economy. In countries where households and firms have a lot of debt, such as China, this is especially true.

Speaking in Indonesia on Tuesday, Christine Lagarde, the head of the International Monetary Fund, delivered an optimistic message about China. “Growth is slowing—but not sharply, and not unexpectedly,” Lagarde said. She went on to express confidence that China would be able to make the switch from an economy based on very high levels of investment and exports to one in which other sources of demand, particularly household spending, pick up some of the slack. “The authorities have the policy tools and financial buffers to manage this transition,” Lagarde said.

Clearly, however, the financial markets weren’t very reassured by this vote of confidence from the I.M.F. president.